One feature of property is that you can apply leverage to it, and that can allow you to control a larger asset base, which can increase your potential returns.
My example last week showed how an investment growing at 5% p.a. with more leverage can outperform an investment growing at 10% p.a. (see here)
So why is debt sometimes thought of as a dirty word?
Well it’s not really… most banks, companies and governments use debt to grow. The alternative is giving away equity or otherwise not having the funds to pursue investments or various growth opportunities.
Our grandparents’ pre-war generation were particularly fearful of debt though and today a lot of the media attributes unstable markets and/or economic misfortunes to its improper use.
Debt can be very dangerous, particularly when people or companies leverage themselves up too quickly (e.g. by taking on debt they can’t safely afford) and/or they use it to buy bad assets more likely to stagnate or even depreciate in value over time.
But sensibly applying leverage to low risk and appreciating assets is a time tested and proven formula for wealth creation.
‘Good’ debt and how it can be used sensibly.
So borrowing money to invest in property really comes down to two things then:
- Doing it safely; and
- Buying assets which will increase in value
Investing in property does not have to be complicated. Following these two simple principles is how you can potentially avoid the most of the common mistakes, and they’re also how you can get over the “fear-of-debt”, which is probably the single biggest factor which holds people back.
When I talk about borrowing safety (rule #1), I’m referring to loan structures whereby you’re not overextending yourself and you can comfortably afford to meet your repayment obligations. It’s also about having stable income and financial “buffers” in place to ensure that there’s always cash available, even if something unforeseen happens, which means you’re never in a position where you’re forced to sell.
Buying properties that will increase in value (rule #2) is about finding the best properties in the right cities and suburbs, with the right attributes, at the right points in the property cycles to reduce risk and maximise the likelihood of strong returns. Good buyers advocates/property experts should not only have the skills, experience, contacts and time to achieve this, they should also have strong research capabilities to validate their advice.
Given the strong growth we’ve experienced in Melbourne and Sydney over the past three years, some people are starting to feel concerned that the cycle might turn soon and the market could pull back 5-10%. Think about this though… if this were to happen then most house prices in Melbourne and Sydney would only being going back to where they were 6-12 months ago.
What is your investment time horizon? Do you still think these houses have the potential to increase in value over the longer term? Are you an investor or a speculator?
Also there’s nothing to say you have to invest in Melbourne or Sydney right now. With the right advisers around you it’s not difficult to buy blue chip properties in interstate markets which are more affordable and arguably at lower points in their growth cycles.
Debt doesn’t have to be a dirty word. If it’s used sensibly it can help you achieve your financial goals more easily.
Question: How do you feel about debt and what is your personal comfort level?
